Sanchez Energy: High Growth, High Margin, High Return

Rapidly-growing midcap producer Sanchez Energy operates mostly in the Eagle Ford Shale. The company's high margins, high growth, and reasonable valuations make it a buy.

Apr 7, 2014 at 12:37PM

The U.S. shale revolution is a great opportunity. Pockets of the country, for example North Dakota and southern Texas, are drilling more than ever before. Shale has given rise to dozens of small, nimble, early moving companies that were able to set up before the "big boys" did. Companies such as EOG Resources (NYSE:EOG) and Continental Resources (NYSE:CLR) are household names now, but they weren't five years ago before either company had entered the shale. 

Sanchez Energy (NYSE:SN), an upstream company which only produces oil (not gas), is an operator that works entirely in the shale. Most of Sanchez's assets are in the Eagle Ford, which is the biggest, most economical shale play save for the Bakken. Sanchez is only a $1.5 billion company. While the company has matured and it can no longer grow its production exponentially, it still grew its total production by triple-digits this year.

Not only is Sanchez a high-grower, it is also a profitable grower. Sanchez's Eagle Ford margin is among the highest of its peers. It's unsurprising that Sanchez also has very good Eagle Ford "well economics," which I believe will further improve as fracking technology advances and best practices are established. I believe that Sanchez Energy is one of the best ways to participate in the North American "shale revolution."

High growth

Sn Growth And Reserves

Sanchez Energy Investor Relations

This chart shows both production and reserve growth for Sanchez since 2011. In 2013, production grew by almost 900%. On a percentage basis, Sanchez will not be able to repeat such a performance this year. However, in absolute terms, Sanchez is still growing at a rate comparable to that of last year, and maybe even a little faster. There are only a handful of names in already-established shale plays that provide 100% production growth. Sanchez is one of those names.

High margin

Sn Margins

Source: Sanchez Energy

This chart shows Sanchez's EBITDA margin versus those of its peers. Peers in this chart include all of the better mid-cap shale names: EOG, GulfportGoodrichPenn VirginiaRosetta ResourcesCarrizo Oil & Gas (NASDAQ:CRZO), and several others. Sanchez makes more per barrel than most of its peers do for a few reasons. First, Sanchez's production is entirely oil. Second, Sanchez produces only in the higher-margin Eagle Ford, and not in any dry gas or natural gas liquids plays such as the Marcellus or Utica. South Texas offers an ideal drilling environment which probably results in the higher margins we see here: Population density in rural southern Texas is very low. Landowners and communities in southern Texas are very friendly to the prospect of drilling. Most of all, the drilling permit process in Texas is very reasonable. 

If Sanchez's recent press release is any indication, its profitability should only improve from here. Just more than a week ago, Sanchez lowered its planned 2014 capital expenditure from $650 million-$700 million to $600 million-$650 million as a result of 'significant decreases' in drilling and completion costs as well as efficiency improvements. This decrease in spending will not result in a change in the number of wells drilled this year. These kinds of process improvements have become apparent in operations all across the Eagle Ford as efficiencies continue to improve in this shale play. That's all the more reason to be in Sanchez Energy.

Bottom line
Despite its impressive growth, Sanchez actually still trades at a reasonable valuation. The stock trades at only 1.57 times book value, significantly below fellow Eagle Ford mid-cap Carrizo at 2.9 times book and EOG at 3.57 times book. Sanchez has great production growth prospects, high margins, and good economics in a premier shale play, which makes it one of the best ways to participate in America's "shale revolution." 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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